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China’s fmedgling merger control regime has become increasingly important to multinational companies investing in China. In the three years since limited antitrust merger review provisions were introduced in March 2003, as part of the Provisional Regula- tions on Foreign Investors Merging with or Acquiring Domestic Enterprises (the Foreign M&A Regulations), China has become an important part of global competition clearance for cross-bor- der transactions. The promulgation of China’s fjrst comprehen- sive competition law, the pending Anti-Monopoly Law (AML), is eagerly awaited; and the search for clues as to how the AML will

• perate is under way.

The Chinese merger control procedures remain relatively unde-

• veloped. They occupy a handful of articles in the Foreign M&A Reg-

ulations, which are labelled ‘provisional’ and are widely expected to be superseded by the AML by late 2006. As with many Chinese laws and regulations, the merger control articles contain a purposeful lack of clarity, with most key terms undefjned in the regulations or in Chinese law. There are no implementing regulations, or publicly available or legally binding decisions. As a result, while regulators have become increasingly sophisticated, the process leaves plenty

• f room for administrative discretion in both interpretation and

enforcement, and parties must often rely on informal administra- tive guidance. Nevertheless, Chinese lawmakers and regulators regularly affjrm their intention to upgrade the Chinese legal system to international standards and further support China’s increasingly market-based

• economy. Passage of a modern antitrust law such as the AML is

a top priority for China in that process. The AML will introduce a somewhat different merger control process and is substantially informed by international practice, while retaining uniquely Chinese perspectives on certain competition issues. There are occasional indications that antitrust policy and enforcement in China may face increasing pressure to target for- eign multinationals in order to protect and benefjt domestic Chinese

• industry. This pressure is exemplifjed by an SAIC report in 2004

detailing perceived anti-competitive practices by multinationals and recommending greater regulation of such behaviour, as well as by a Ministry of Technology report in 2005 cataloguing alleged misuses

• f intellectual property rights by multinationals. The Foreign M&A

Regulations themselves provide a small indication of the seemingly protectionist sentiments that still exist in Chinese law: they apply

• nly to transactions involving foreign parties, while also reaching

purely offshore transactions if the parties or their affjliates have cer- tain qualifjed assets or business in China. Despite these indications and widespread concern in the Western business press, however, it is unlikely that the Chinese government will permit existing or new competition laws to interfere in a systematic or substantial way with foreign investment in China.

Substantive standard

The principal substantive issue in antitrust review of a transaction under the Foreign M&A Regulations is framed by articles 20 and 21: whether a transaction will cause “excessive concentration in the domestic market, impede or disturb rightful competition, and harm domestic consumers’ benefjts”. Article 3 also generally requires that foreign investors “must not cause excessive competition or exclude

• r restrict competition”.

Neither the regulations nor other Chinese laws provide addi- tional insight into how the responsible government ministries conduct their competition analysis. It has become routine for com- panies to submit merger fjlings under the regulations for pre-merger

• approval. Although the details and dispositions of these matters are

not publicly available, it is reasonable to assume that the Chinese regulators’ analysis will remain less practised and technical than that employed in more mature competition jurisdictions, at least over the near term. Indeed, anecdotal evidence suggests that most merger fjlings and reviews under the Foreign M&A Regulations have con- sidered only basic structural competitive issues and undertaken no detailed economic analysis. Nevertheless, parties may attempt to raise whatever competitive arguments and market information they have, and can expect to encounter individual regulators with sub- stantial experience and training in international competition regimes and analysis.

Scope of regulatory coverage

The Foreign M&A Regulations cover only transactions involving foreign parties. There are separate reporting thresholds for onshore and offshore transactions. Onshore transactions Article 2 states that the regulations cover mergers and acquisitions between foreign investors and domestic Chinese enterprises (ie ‘onshore transactions’) of two types:

• equity transactions, meaning:
• a foreign investor’s acquisition of equity interest in a purely

domestic enterprise and the subsequent conversion of that domestic enterprise into a foreign-invested enterprise (FIE),

• r
• a foreign investor’s subscription to the increased capital of

a purely domestic enterprise and subsequent conversion of that domestic enterprise into an FIE; or

• asset transactions, meaning:
• a foreign investor’s establishment of an FIE to acquire and

use the assets of a domestic enterprise (including those of an FIE), or

• a foreign investor’s direct acquisition of the assets of a

domestic enterprise (including those of an FIE) and contri- bution of those assets to establish and operate an FIE. The regulations as written do not appear to cover onshore transac- tions undertaken by pre-existing FIEs, although such transactions may be covered by other foreign investment-related regulations without competition review mechanisms. Nor do the regulations appear to cover acquisitions by domestic Chinese companies, even

• f foreign companies or FIEs.

Chinese merger control

Peter J Wang Jones Day

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Offshore transactions The term ‘overseas merger or acquisition’ (ie ‘offshore transaction’) used in Article 21 is not defjned in the Foreign M&A Regulations, and its application to the merger review process remains uncer-

• tain. If interpreted broadly, the term potentially could cover nearly

any transaction occurring outside of China, so parties and counsel should carefully evaluate the potential impact of their deal structure and whether their transaction may reach the reporting thresholds for

• ffshore transactions described below. On the other hand, although

many offshore transactions arguably might not technically trigger merger review under article 21, parties often anticipate the need to obtain other approvals from the same ministries (eg, relating to

• ngoing operations of, or transfers of interests in, existing subsidi-

ary FIEs in China), and thus may feel it advisable in close cases to seek merger review. Other transaction types Under article 24, the Foreign M&A Regulations also cover the direct acquisition by a foreign investor of an equity interest in an existing FIE, to the extent that such transactions are not governed by sepa- rate regulations relating to the transfer of stakes in FIEs. Article 24 also states that the regulations cover transactions involving a foreign investor-owned China holding company (in Chinese legal parlance, a ‘foreign investment company’) and a domestic enterprise. Transactions that do not fall within these defjned categories do not appear to be covered by the regulations.

Regulatory authorities

MOFCOM and SAIC Under articles 20 and 21 of the Foreign M&A Regulations, both the Ministry of Commerce (MOFCOM, formerly known as the Min- istry of Foreign Trade and Economic Cooperation or MOFTEC) and the State Administration of Industry and Commerce (SAIC) may receive and review merger control fjlings. The same two agen- cies also are responsible for the approval and registration of foreign

• investments. Both agencies have been involved in drafting the new

Anti-Monopoly Law, which in some incarnations has contemplated the creation of a separate, new antitrust enforcement agency. SAIC also is designated as one of the chief enforcement agencies for Chi- na’s Anti-Unfair Competition Law, which contains a limited number

• f competition-related provisions.

The extent of each agency’s responsibilities and reviewing stand- ards, methods and procedures is not clearly set forth in the Foreign M&A Regulations. This lack of clarity presents signifjcant chal- lenges for foreign investors in preparing, submitting, and defending merger notifjcation fjlings. In practice, notifjcations are submitted to both ministries, but MOFCOM generally has been more active in review of merger fjlings. Specialised industry review Neither the Foreign M&A Regulations nor other Chinese laws provide for competition-based merger review by other government

• authorities. Other laws and regulations governing foreign invest-

ment in China (such as the Investment Catalogue), however, may affect the feasibility or approval of foreign M&A transactions, pro- viding transactions in certain industries with higher scrutiny or even across-the-board prohibition. In general, MOFCOM and SAIC or their local subordinates may notify and consult with other relevant government authorities regarding each transaction. Mandatory reporting requirements The thresholds for mandatory reporting are different for onshore and offshore transactions. Some thresholds relate to the sizes of the parties and their affjliated enterprises as measured by business turnover, cumulative annual number of acquired businesses, market share, or size of assets. Others relate to the effect of the transaction

• n market concentration as measured by combined market shares.

Each applicable threshold will independently trigger mandatory merger notifjcation and approval. Onshore transactions For onshore transactions, article 19 of the Foreign M&A Regula- tions provides four independent thresholds requiring merger noti- fjcation and review:

• ne party (if foreign, including affjliates) has a one-year China

business turnover exceeding 1.5 billion renmimbi (approxi- mately US$185 million);

• ne party (if foreign, including affjliates) has in one year acquired

more than 10 domestic enterprises in related industries;

• ne party’s (if foreign, including affjliates) market share in China

has already reached 20 per cent; or

• as a result of the transaction, one party’s (if foreign, including

affjliates) market share in China will reach 25 per cent. Offshore transactions Article 21 of the Foreign M&A Regulations provides fjve separate thresholds for mandatory reporting of offshore transactions:

• ne party holds assets within China worth over 3 billion ren-

mimbi (approximately US$370 million);

• ne party has business turnover in the China market in that year

worth over 1.5 billion renmimbi;

• ne party’s (along with its affjliated enterprises) market share in

China has already reached 20 per cent;

• as a result of the transaction, one party’s (along with its affjliated

enterprises’) market share in China will reach 25 per cent; or

• as a result of the transaction, one party will directly or indirectly

hold equity interests in more than 15 FIEs in related industries. Exceeding any of these thresholds requires that the offshore transac- tion plan be reported to MOFCOM or SAIC either (a) before the plan is publicly announced or (b) simultaneously with the submis- sion of the plan to the regulatory authorities in the country where the transaction is to occur. In practice, the enforcement ministries may authorise more time for preparation and submission of a detailed

• fjling. The regulations do not appear to require reporting when nei-

ther public announcement nor a merger fjling in the country of the transaction is necessary. No minimum transaction size It should be noted that, unlike in some jurisdictions, transaction size itself is not relevant to the mandatory notifjcation thresholds for

• nshore transactions. Thus, for example, a transaction in a small

and economically insignifjcant industry may still require antitrust notifjcation and review if the parties’ combined market share will exceed 25 per cent. For offshore transactions, the scope of potential reporting obli- gations is even broader. The regulations may require reporting of transactions even if they have no competitive effect in China: for example, if one party’s market share, business turnover, or assets in China exceed the threshold limits, even though the other party has no assets or business in China. The use of special acquisition vehicles may help to avoid such results. Use of acquisition vehicles For onshore transactions, the requirement that the market share, business turnover, and prior domestic acquisitions of all ‘affjliates’

• f foreign acquirers be aggregated means that mandatory reporting

cannot be avoided by the use of special acquisition vehicles. In any

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event, Chinese law generally does not permit the use of such vehi- cles, at least in domestic transactions. For offshore transactions, in practice, the fjrst two tests above are applied by the reviewing agencies to require that the assets or business turnover of a party’s affjliated enterprises in China must be aggregated with those of the party itself, so that the thresholds are considered for each ‘party’ on an aggregated, group-wide basis. Issues for clarification Given the lack of detailed implementing rules or formal guidance, many issues may require further clarifjcation from the reviewing agencies, including:

• what degree of control or cross-ownership is required for ‘affjli-

ates’;

• the time period over which to measure China business turnover;
• what ‘related industries’ are;
• how to measure ‘China market share’ and determine the rel-

evant product market(s),

• what accounting principles must be used in determining a par-

ty’s total China assets and business turnover; and

• what ‘directly or indirectly’ means in the context of holding

equity interests in FIEs, and how large those interests must be to qualify. Discretionary review of onshore transactions Even if the thresholds for mandatory reporting are not met, under article 19, MOFCOM and SAIC may be requested by domestic competitors, relevant government authorities, or industry associa- tions to engage in a discretionary review of an onshore transaction. MOFCOM and SAIC may require the parties to such a transac- tion to report a transaction if, upon such a request, the regulators determine that the transaction will “involve a very large market share” or there exist factors that will “seriously infmuence market competition, the national economy, and the livelihood of the people and national economic safety”. Article 3 supports this by stating that foreign investors “must not disturb social and economic order

• r damage social and public interests”. These broad terms provide

substantial room for domestic competitors, local authorities and regulators to require review of onshore transactions independent of their competitive signifjcance. There is no similar discretionary reporting mechanism for off- shore transactions. Exemptions from review Finally, under article 22 of the regulations, the parties to a report- able transaction may seek an exemption from regulatory review if the transaction “can improve conditions for fair market competi- tion,” “restructures loss-making enterprises and assures employ- ment,” “introduces advanced technologies and managerial talent and improves the enterprise’s international competitiveness,” or “can improve the environment.” As with other practice under the regulations, the exemptions require approval from MOFCOM or SAIC and thus are subject to substantial administrative discretion. Notification and approval procedures The Foreign M&A Regulations do not provide much detail about the mandatory reporting and review of covered transactions. Who should file The regulations do not specify which party or parties should fjle a noti- fjcation with MOFCOM or SAIC. In practice, either one party (usually the acquirer), or both parties together, may fjle a notifjcation. When to report The regulations do not specify a time period within which the parties to a transaction must report an onshore transaction that meets the reporting thresholds. The parties to an onshore transaction must, however, submit their merger fjlings (and perhaps evidence of clear- ance) to obtain foreign investment approval and registration. It is understood that the government ministries have received both pre- and post-closing notifjcations. The regulations expressly require that the parties to a reportable

• ffshore transaction notify MOFCOM or SAIC of their merger plan

before the plan is publicly announced or at the same time that it is submitted to the regulatory authorities of the country in which the transaction will occur. The ministries may grant parties additional time to prepare and fjle detailed information relating to notifjcation, however. What to report The regulations provide no detail about what information must be provided to MOFCOM or SAIC as part of the reporting process, beyond the fact that a proposed transaction is reportable. Other articles in the regulations require the submission of various docu- mentation to the relevant ministries for foreign investment approval and registration, but that documentation does not appear to include any separate competition-related information or documentation. In practice, the government ministries (particularly MOFCOM) have requested that merger review fjlings include the following:

• basic information about the parties, such as the parties’ names,

respective legal addresses, business scopes, and China affjliates and FIEs;

• a description of the transaction, including the nature of the

transaction, the amount involved, relevant industries and prod- ucts, and the economic rationale for the transaction;

• the parties’ annual sales and market shares in all relevant mar-

kets, along with the sources of any market-share data;

• defjnitions of relevant markets and identifjcation of top competi-

tors in each;

• information regarding merger control fjlings in other jurisdic-

tions; and

• any other information requested by the reviewing authorities.

Review and approval The regulations also provide little detail about how, on what basis, and when MOFCOM and SAIC will review and approve or disap- prove a proposed transaction based on competitive concerns. The only required process is set forth in article 20, which pro- vides that, for onshore transactions, MOFCOM or SAIC may fjrst determine that a transaction “might cause excessive concentration in the domestic market, impede or disturb rightful competition, and harm domestic consumers’ benefjts,” in which case the ministries will “jointly or separately convene the appropriate departments, institutions, and enterprises as well as other concerned parties for a public hearing within 90 days of receiving all requisite documents.” After this hearing, MOFCOM or SAIC “will then decide whether to approve or reject the application according to law.” No similar pro- cedure is provided for offshore transactions, which are not explicitly barred from closing pending merger review. In practice, MOFCOM has implemented a 30-working day (pre- viously 30-calendar day) ‘waiting period’ during which the parties may not close, whereas SAIC has implemented a 30-calendar day waiting period. The waiting period begins when the government agen- cies deem the parties’ information submissions to be complete and all additional requests for information satisfjed. Merger fjlings generally will be deemed approved after the expiration of the waiting periods without issuance of formal no-action or no-jurisdiction letters.

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In the absence of implementing rules or more specifjc offjcial guidance, the regulations do not make regulatory compliance and deal planning easy. There are many opportunities for extra-competi- tive concerns and administrative discretion to enter and affect the review and decision processes. Moreover, given the absence of clear procedures and timing, there is no way accurately to predict how long any particular merger review may take if the agencies should raise concerns and decide to convene a hearing. For example, the regulations do not specify:

• how MOFCOM or SAIC make the preliminary determination

that the transaction is of competitive concern and requires a hearing;

• whether and how the parties may provide information and

argue their case prior to such preliminary determination;

• which ‘requisite documents’ are to be provided by the parties;
• what information may be provided by or required of third par-

ties;

• the timeline for MOFCOM or SAIC to request and parties to

provide documents or information;

• how MOFCOM or SAIC determine what governmental depart-

ments, institutions, enterprises and concerned parties may par- ticipate in the hearing;

• the procedures for conduct of the hearing itself;
• the timeline for MOFCOM or SAIC to make their fjnal deter-

mination; and

• which legal principles, arguments, and analytical methods

MOFCOM or SAIC will consider in the review process. This is compounded by a lack of clarity regarding the division of reviewing responsibilities between MOFCOM and SAIC. There is no assurance that the two agencies will employ consistent and trans- parent review standards. Thus, China’s ‘provisional’ merger-review process gives rise to potentially formidable challenges for foreign investors whose transactions require notifjcation and review. Non-compliance The Foreign M&A Regulations do not provide a mechanism for penalising non-compliance with their merger reporting or other

• requirements. There is no express authorisation for MOFCOM or

SAIC to seek the reversal of a transaction that was not properly reported for merger review. Thus it is unclear whether any such non- compliance might result in administrative or civil fjnes, a cease and desist order, rescission or unwinding of a transaction, or even crimi- nal penalties, although all may be possibile. Nonetheless, MOF- COM and SAIC believe the merger control regime to be enforceable

• n its face and have received many fjlings for merger clearance in

the last three years. Moreover, to obtain foreign investment approval and registra- tion for onshore transactions, Articles 12 and 15 of the regulations require that the parties submit their merger fjlings (and perhaps evidence of antitrust clearance) to the foreign investment approval

• authorities. Accordingly, if the relevant authority determines that a

transaction should have been reported for antitrust review, it may simply refuse to approve or register the transaction, rendering it legally ineffective even if consummated by the parties. In extreme cases, the authorities could issue rectifjcation orders and even sus- pend or revoke the business licence of the relevant FIEs. Appeal Although the regulations do not provide for any appeal mecha- nism, Chinese administrative law permits a party wrongfully denied approval to seek review either through administrative appeal or by fjling administrative suit in the relevant Chinese courts. As a formal matter, Chinese courts may not have the judicial power substantively to review such a denial. Nevertheless, a favourable court decision may be useful in helping to convince the ministry to reconsider (if not reverse) its decision.

The draft Anti Monopoly Law

China’s lawmakers are considering a draft comprehensive Anti- Monopoly Law (AML) that addresses a far wider range of com- petition issues than do the Foreign M&A Regulations. MOFCOM frequently has solicited substantial oral and written comments on the draft law from Chinese and foreign antitrust law experts over the past few years. Lawmakers generally appear eager to consider and incorporate many elements of standard international merger control practices, although perhaps gradually over time and only with adaptations to account for unique Chinese concerns and mar- ket conditions. Recent drafts of the Anti-Monopoly Law, in late 2005, included a chapter containing a merger control process that, among other things:

• applied to all consolidations, whether by merger, asset or share

acquisition, joint venture, or any other means;

• covered consolidations involving foreign or domestic compa-

nies;

• covered all transactions, onshore or offshore, that restrict or

affect competition within China, even if they occur outside China;

• considered the use of reporting thresholds based upon market

shares, assets and sales turnover;

• envisioned a new regulator, the Anti-Monopoly Management

Body of the State Council (AMB);

• provided a list of the types of documentation and information

the parties must provide to the AMB for review, including fjnan- cial statements, basic information regarding the parties, the rea- sons for the proposed consolidation, the competitive situation in relevant markets, the contemplated consolidation date, and any “other documents required by the AMB”;

• required the AMB to make a decision on whether to pursue

a further review within approximately 30 working days and to make a decision on whether to approve or not approve the transaction within an additional 90 to 120 working days after receiving all requested documentation; further, MOFCOM may extend the investigation period for as long as 30 working days under the circumstances that (i) the notifying party or parties agree or agrees to extend such period; (ii) the documents sub- mitted by the notifying party or parties are inaccurate and need further verifjcation; (iii) the relevant circumstances have signifj- cantly changed after notifjcation by the given party or parties;

• permitted the AMB to “attach restrictive conditions” to any

approval;

• required the AMB to consider the following factors when decid-

ing whether to approve a consolidation: (i) the parties’ market shares in relevant markets and their ability to control those mar- kets; (ii) the consolidation of the relevant market; (iii) the likeli- hood of elimination or restriction of competition in relevant markets as a result of the proposed consolidation; (iv) the effect

• f the proposed consolidation on market access and technologi-

cal progress; (v) the effect of the proposed consolidation on con- sumers and upstream or downstream enterprises; (vi) rationales for the consolidation and economic effjciencies that are likely to result from it; (vii) the effect of the proposed consolidation on the development of the national economy and public interest; and (viii) any other factors the AMB deems relevant. Commentators have suggested further revisions to the draft AML may alter a number of merger review-related matters, possibly

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Jones Day

30th Floor Shanghai Kerry Centre 1515 Nanjing Road West Shanghai 200040 People's Republic of China Tel: 86 21 2201 8000 Fax: 86 21 5298 6569 Peter J Wang Tel: +86 21 2201 8040 e-mail: pjwang@jonesday.com Tracing its origins to 1893, today Jones Day encompasses more than 2,200 lawyers resident in 28 locations and ranks among the world's largest and most geographically diverse law fjrms. The fjrm acts as principal outside counsel to, or provides signifjcant legal representation for, more than half of the Fortune 500 companies, as well as to a wide variety of other entities, including pri- vately held companies, fjnancial institutions, investment fjrms, healthcare providers, retail chains, foundations, educational institutions and individuals. Jones Day's antitrust and competition law practice consists of approximately 100 counsellors and litigators, located in 16 offjces in the United States, Europe and Asia. We are recognised in profes- sional publications and rankings as one of the leading antitrust/competition practices in the world. We provide antitrust and competition law services with respect to mergers and acquisitions, govern- ment criminal and civil investigations, antitrust litigation, antitrust/intellectual property issues, and the full range of counselling subjects (including distribution, electronic ventures of various kinds, pricing, trade associations, licensing, and standard-setting). In Europe and Asia, Jones Day has nearly 40 antitrust specialists in Brussels, Frankfurt, London, Madrid, Milan, Munich, Paris, Shanghai and Tokyo. We have signifjcant experience with merger notifjcations before the EC and national authorities, cartel investigations, competition issues involv- ing the telecommunications industry, state aids, dominant fjrm issues, and the full range of counsel- ling issues. We practice before the Court of First Instance and the Court of Justice of the EC, and national and local courts in most countries where we have offjces.

including the choice of regulatory authority; the applicable reporting thresholds; and various details of the merger review mechanism. The revised draft has been submitted to China’s National People’s Con- gress and is expected to pass into law as early as the end of 2006, possibly with additional modifjcations. Because there are so many business and administrative constituencies with competing interests in the ultimate outcome, there is no way to predict how long the law will take to arrive.

Conclusion

Without detailed implementing rules or formal offjcial guidance, China’s merger control regime still is a work in progress. In terms

• f practical application, it leaves many issues unaddressed, includ-

ing the substantive standards, precise time periods, and procedures for merger review. Merger notifjcation and approval requirements remain somewhat uncertain and unpredictable and must be evaluated and handled on a case-by-case basis. Consultations with experienced counsel and with relevant Chinese authorities are recommended to assess the potential impact on any given transaction and determine an appropriate transaction structure and course of action.